Noel Whittaker explains how index funds work.
The search for ways to grow your nest egg has never been more challenging. Personal money specialist Noel Whittaker explains an option for YourLifeChoices member Jim*.
What is an index fund and how does it work? How do we access the fund?
A. An index fund simply replicates a specific large index, such as the All Ordinaries.
Index means a measure of value. The consumer price index measures the cost of goods; the happiness index measures how happy the citizens of a country are, based on certain criteria. And a stock exchange index measures the value of a stock exchange.
There are many stock exchanges around the world, and many indexes within those stock exchanges. The indexes most used in Australia are the ASX 300 and the All Ordinaries. Their performance is roughly the same as each other because the bulk of the money invested in the ASX is in the ASX 300. The extra 200 or so companies included in the All Ords are simply not that large a part of the market. The ASX 300 index is itself broken down into sub-indexes, such as Financials, Materials and Healthcare. Financials and Materials account for roughly 60 per cent of the ASX 300, and the largest company in Australia – which at date of writing is BHP – accounts for 9 per cent of the ASX 300.
The top 10 shares in the ASX 300 are worth more than the bottom 277 combined.
Exchange traded funds (ETFs) are funds that trade on a stock exchange, just like ordinary shares. They combine the investment advantages of a managed fund with the ease and cost-effectiveness of share trading. You can use ETFs for cost-effective, easy access to markets and asset classes you might not otherwise have access to, such as debt, derivatives, currency and commodities.
Two index funds I use are:
- SPDR S&P/ASX 200 ETF (STW)
- Vanguard Australian Shares Index ETF (VAS).
If you want to add a bit of spice to your life, you could go the other route, and have a go at picking shares yourself. As somebody who has been trying to do this for many years, I can assure you it’s much harder than it seems. For starters, the key to being successful is to find an undervalued share, which is hard to do given the wealth of information available. Most of the weekend papers publish brokers’ tips; if you choose a stockbroker they will make recommendations for you, or you could subscribe to blogs, magazines or newsletters that specifically focus on finding value in the share market. As far as I’m concerned, it’s all too difficult, and way beyond the scope of this book. But best of luck, if that is the way you want to invest.
* Not his real name.
Noel Whittaker is the author of Making Money Made Simple and several other books on personal finance.
Are you adept at understanding index funds? Or will you have a go now that bank interest rates are so low?
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Disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.